States emerged outwardly unscathed from the New Year’s Day congressional fix that prevented the economy from tumbling off the fiscal cliff, but statehouse fiscal officers aren’t popping the corks of any leftover champagne.
Despite the anxiety and partisanship surrounding the last-minute approval of this legislation, it was a relatively easy decision for Congress: the jobless benefits are necessary and lower taxes are popular. What isn’t popular are the cuts in government services that some president and some Congress will eventually be forced to make, with the national debt at $16 trillion and growing exponentially. Congress, however, has turned delay into an art form. HR 8 put off the hard choices by postponing for two months massive domestic and defense budget cuts — known as a “sequestration” — that were due to kick in automatically on Jan. 1.
This delay could wind up squeezing states, said Scott D. Pattison, executive director of the National Association of State Budget Officers. If Congress and President Barack Obama go ahead with the sequestration in March, he said, states would be affected at the very time they’re preparing budgets for the next fiscal year.
Congress “left uncertainty on the table,” said Michael Bird, general affairs counsel of the National Conference of State Legislatures (NCSL). He observed that if Congress eventually makes significant budget cuts, states and local governments would be forced to accomplish in nine months what they would have had a year to do if the sequestration had gone into effect as scheduled. Had Congress passed the full sequestration package, it would have cost states some $13 billion in federal aid this year, he said.
It’s not only states that are uncertain. Deploring the limits of the congressional fix, The Economist wrote that Congress had failed to control the unsustainable path of health-care spending and other entitlements and nothing to reform the “hideously complex and distorting tax code ... and virtually nothing to close America’s big structural budget deficit.”
The stock market enjoyed a relief rally after HR 8 was passed, but many analysts see rough waters ahead as Congress debates whether to increase the debt limit. Congressional Republicans are determined to obtain spending cuts as a condition of voting for the debt limit increase despite Obama’s insistence that he will not negotiate on this issue.
Public credit is also at risk. The ratings agency, Standard & Poor’s, issued a report in December declaring that a weak economy threatened the credit rating of state and local governments. Because of the unresolved budget cuts, passage of HR 8 has only partially lifted this “fiscal cloud,” S&P said in a Jan. 2 statement.
Viewed in isolation, HR 8 is mildly helpful to states in the short run. The measure extended more than four dozen individual, business and energy tax credits, as well as optional state and local sales tax deductions. States also will benefit if postponement of the budget cuts boosts the anemic economic recovery. States are still feeling the effects of the Great Recession; Pattison says revenues have not reached 2008 levels when adjusted for inflation.
The long-run concerns of the states are multiple — and divergent. Eight states — Idaho, Kentucky, Maryland, Mississippi, South Dakota, Utah, Virginia and Wyoming — are scheduled to pass budgets and wrap up their sessions in late March or early April. Unless they have what Bird calls “just-in-case funds” in their budgets to make up for reductions in federal aid, these states presumably would have to go back into session and revise their budgets to accommodate any cuts in federal aid. Vermont and Virginia currently have such funds in their budgets.
Six states will have income tax revenues reduced by HR 8, which raised federal income taxes on individuals making more than $400,000 and families making more than $450,000. Alabama, Iowa, Louisiana, Missouri, Montana and Oregon allow taxpayers to deduct federal income taxes on state returns, meaning that higher federal taxes reduce state revenues.
HR 8 also eliminated the state estate tax credit, which returned a share of federal inheritance taxes to states. Some states had anticipated this. The California budget, for instance, included a reduction in another fund that offsets the loss of $45 million from the state estate tax credit this year.
All these tax changes are minor in comparison to the negative economic impact that would be experienced in several states if Congress decides to impose the immense reductions in the defense budget that were contained in the sequester. This would especially harm states with many military bases and installations, among them California, Arizona, Connecticut, Hawaii, Maryland, Washington and Virginia.
Congress passed HR 8 after Obama and House Speaker John Boehner, R-Ohio, tried and failed for the second time to secure what has been called a “grand bargain” that would include tax reform and entitlement cuts. Despite Boehner’s inability to win support from conservatives in his House Republican caucus for tax increases and opposition from liberal Democrats to spending cuts in Medicare or Social Security, talk of a “mini-bargain” remains alive.
Such a bargain would inevitably include changes in the tax law to reduce or eliminate various deductions or loopholes. States want to preserve the present deductions for state and local taxes that taxpayers are allowed to take on their federal returns.
Beyond the tax laws, states are wary of any attempt to reduce the federal share of programs in which costs are shared with the states. Medicaid, the federal-state program that provides health care for the poor, is a particular concern. The sequester exempted Medicaid from cuts, but Congress could revisit the issue.
“States are nervous about Medicaid,” Bird said.
He said the timing would not be right for changes in the existing formula, as states wrestle with implementing the federal health-care law. The centerpiece of Obamacare, as even Obama now calls it, is the creation of accessible marketplaces known as exchanges in which individuals and families will be able to shop online for affordable health-care policies. Only 18 states have signed up to create the exchanges, which are supposed to be established by October with the first policies offered on Jan. 1, 2014.
But even if Congress leaves well enough alone on Medicaid, states are inevitably going to be faced with reductions in federal aid. Federal aid on “discretionary spending” — programs that include education and community services, among other things — was reduced by more than 4 percent in 2011 and by 2.7 percent in 2012.
The cuts are coming. States just don’t know where or when.
— Lou Cannon, a Summerland resident, is a longtime national political writer and acclaimed presidential biographer. His most recent book — co-authored with his son, Carl — is Reagan’s Disciple: George W. Bush’s Troubled Quest for a Presidential Legacy. Cannon also is an editorial adviser to State Net Capitol Journal, which published this column originally. Click here to read previous columns. The opinions expressed are his own.